Directional Options Trading
Strategy And Position Management
Bill Looney – CBOE Global Business Development
Oleg Lugovkin – Volatility PM – Argentiere Capital
Copyright ©2014 CBOE. All rights reserved
2Introduction
OBJECTIVES
Emphasize/Maintain a Directional Mindset
Review Quantitative Factors
Review Trade Examples/Scenarios
Discuss Structuring and Risk Management
Copyright ©2014 CBOE. All rights reserved
3What Is Directional Trading?
Directional Trading Strategies:
Utilize options to express a view or opinion on potential stock
movement
Focus on achieving “leverage” through proper “Delta” selection
Analyze Key Quantitative Factors to Determine the “Best” Strategy
to Utilize
The Directional Trading Process is:
Define View
Structure (Hard)
Risk Manage (Art)
Copyright ©2014 CBOE. All rights reserved
4Directional Traders Mindset/Objective
Hedging
Speculative
Yield
Directional trading seeks to achieve “one” of the above goals
Option strategies can fall under different goals
Directional Traders remain OPEN to exploring ALL possible
strategies
When trading “directionally,” it is REQUIRED to define the goal
Copyright ©2014 CBOE. All rights reserved
5Facts and Stats from the Sell-Side
For 2014, Directional Trading Strategies Dominate Desk Flows
United States Equity Markets Participants Are “Bottoms Up” Investing
Directional Strategies Are Not just for “Hedge Funds”
Between 75% to 85% Of Flows are Single Stock Related
Most Popular Strategies Are:
M&A Based Strategies – Term Structure Trades – Reversal/Conversions
Directional Long/Short and Stock Substitutes Strategies – Upside Calls
Yield Generation – Short Put Sales outsize Active Overwriting
Copyright ©2014 CBOE. All rights reserved
6Quantitative Factors
Implied Volatility (Vega)
Volatility is a measure of price variation over time
The markets attempt to “anticipate the anticipation”
Implied volatility is forward-looking (the market’s estimate of future
volatility)
Historical volatility is calculated from known price behavior in the
Copyright ©2014 CBOE. All rights reserved
7Quantitative Factors
SKEW
Difference between implied volatility levels at different strike
prices
Defines the curve of volatility
Serves as a gauge for determining possible risk scenarios and
market positioning
Copyright ©2014 CBOE. All rights reserved
8Quantitative Factors
GAMMA
The rate of change in delta with respect to the underlying price
Mathematically, gamma is the second derivative of an options value
with respect to underlying price
Used to gauge the price movement of an option, relative to the
amount it is in or out of the money. (Change in DELTA)
Copyright ©2014 CBOE. All rights reserved
9Quantitative Factors
THETA
A measure of the rate of decline in the value of an option due to the
passage of time. (Time Decay)
The measure of theta quantifies the risk that time imposes on
options as options are only exercisable for a certain period of time
Time has importance for option traders on a conceptual level more
than a practical one, so theta is not often used by traders in
formulating the value of an option
Copyright ©2014 CBOE. All rights reserved
10Quantitative Factors And Momentum Names
Facebook and GOGO
Facebook (FB) - Earnings Date Change
Accounts utilized WEEKLY options to:
Take Advantage of Shift in Volatility
Change Strike Exposure
GOGO Inc. (GOGO) – High Implied Volatility Alternative
Accounts Sought Long Exposure Into Earnings
Took Advantage of Cheaper Longer Dated ITM Volatility
Purchased Higher Delta Options Achieving Intrinsic Value
11
Why Use Options for Directional Trading?
To create leverage through optionality
To limit downside
To express views on timing or trading ranges
→ The lower the volatility, the higher the leverage you get from
using optionality
0% 100% 200% 300% 400% 500% 600% 700% 70% 75% 80% 85% 90% 95% 100% 105% 110% 115% 120% 125% 130% Apple priceApple Sep14 ATM straddle value at 15 and 30 vol
PNL 15 VOL PNL 30 VOL
12
Implied Volatility Is Key Driver of Option Prices
Major drivers of option pricing:
Implied Volatility
Maturity
Implied Volatility will tell you if the option is cheap
or expensive and if it provides you with high leverage
Options can be compared to insurance premium
→ premium goes up as uncertainty increases
Rates
13
How to Evaluate Implied Volatility?
Implied vs Realized
– the basics of the volatility
Spread/Peer Analysis - FX effect
– EU vs US, XOM vs CVX, JPY vs NKY
Cap Structure Analysis
– is credit telling us something else?
Event Risk
– are earnings / large catalyst mispriced?
Correlation Analysis
– are components or benchmark cheaper?
Imbalances between supply and demand of volatility create
inefficiencies such as skews and term structures
14
Supply / Demand Opportunities
Term Structure
12.0% 14.0% 16.0% 18.0% 20.0% 1m 3m 6m 9m 1y 18m 2y 3y 4y 5y 6yAsia vs US Term Structure
SPX NKY 10% 12% 14% 16% 18% 20% 22% 24% 75 80 85 90 95 100 105 110 115 120 125
1 Year Skew slope Asia vs US
SPX NKY
Skew
Demand for US long-term
protection
Short-term call overwriting in US
Supply of puts in Asia for yield
enhancement purposes
Demand for calls in Asia from
Macro and Retail
SPX NKY 1M
9.51%
7.01%
3M5.77%
2.76%
6M4.30%
1.62%
9M3.60%
1.10%
1Y3.13%
0.86%
2Y2.20%
0.38%
15
Exploiting Term Structure and Skew Inefficiencies
Trade example 1: Leverage on upside convexity
Options Quick Pricer 3.2Underlying
Spot Price Market Maturity
Strike
Strike%
C/P A/E Amount Notional, $
Vol
Price
price %
spx index
1945.00 CBOE
19-Sep-14
2,033 104.50%
C
E
55,000
106,975,000
8.75
1.16
0.06%
nky index
15500.00 OSE.
19-Sep-14
16,198 104.50%
C
E
-70,000
-10,610,209
16.85
97.51
0.63%
10.0
0% 1000% 2000% 3000% 4000% 5000% 6000% 7000% 8000% -5% -4% -3% -2% -1% 0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%PNL 10 by 1: 6 weeks to maturity
PNL %Idea:
benefit from a broad based rally
take advantage of structural
inefficiencies
Structure:
buy 10x SPX calls vs 1x NKY/RTY/..
flat premium
10x leverage
Risk Management:
diversify short leg
16
Exploiting Term Structure and Skew Inefficiencies
Trade example 2: Outperformance Asia over US
Idea:
NKY outperformance over SPX on upside
Structure:
Jun15 102%-114% call spread switch
Premium flat
Risk Management:
Requires consistent monitoring
Needs to be rolled or taken off when targets are met
Options Quick Pricer 3.2
Underlying
Spot Price Market Maturity
Strike
Strike%
C/P
A/E
Amount
Notional, $
Vol
Price
price %
nky index
15500.00 OSE.
19-Jun-15
17,670
114.00%
C
E
-660,000
-100,039,116
18.59
320.3401
2.07%
nky index
15500.00 OSE.
19-Jun-15
15,810
102.00%
C
E
660,000
100,039,116
18.37
825.8537
5.33%
3.26%
spx index
1945.00 CBOE
19-Jun-15
2,217
114.00%
C
E
51,500
100,167,500
10.84
6.7944
0.35%
spx index
1945.00 CBOE
19-Jun-15
1,984
102.00%
C
E
-51,500
-100,167,500
14.06
71.4916
3.68%
17
Exploiting Skew Inefficiencies
Trade example 3: SPX calls vs puts
Idea:
Long market
Use skew inefficiencies to reduce
downside
Structure:
6 week 12x 105% call vs 1x 95% put
Costless
Options Quick Pricer 3.2
Underlying Spot Price Market Maturity Strike
Strike%
C/P
A/E
Amount Notional, $ Vol
Price
price %
spx index
1940.00 CBOE
19-Sep-14
2,037 105.00%
C
E
62,000 120,280,000
8.71
0.7473
0.04%
spx index
1940.00 CBOE
19-Sep-14
1,843
95.00%
P
E
-5,000
-9,700,000
16.50
9.1895
0.47%
12.2974
-8% -6% -4% -2% 1% 3% 5% 7% 9% 11% 94% 96% 98% 100% 102% 104% Underlying price MTM value18
Exploiting Vol of Vol premiums
Trade example 4: Downside protection / hedging
Idea:
Buy downside protection
Structure:
VIX® wings bid for crash protection
VIX® expired only 4x below 12 since
‘06
Avoid the roll down on the futures
Buy 17/23 Sep14 Call spread vs 12 Put
Costless
50 70 90 110 10 11 12 13 14 15 17 19 21 23 25 27 Implie d v o l StrikeVIX® Skew
Sep-14 VIX SKEW
Risk Management:
protection from 17 – 23
Roll the structure to higher strikes
once ITM
Buy back 12 put when worthless
-4 -2 0 2 4 6 8 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 Pa y o ff VIX® Settlement Pay off
19
The Magic of Low Volatility
Trade example 5: Contrarian trade on Silver
Idea:
Get long Silver after a 60% correction
Benefit from vol at a 8 year low
Benefit from any upside rally or shock
(rerating of vol levels)
Structure:
Simply buy Jan16 ATM call is
trading at 2USD
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Tradelegs Intro.2014-07-23.v1 20 20
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Benefits
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fit, letting you easily shape the strategy to match your precise
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its uncertainties without the risks inherent in oversimplification
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Tradelegs Intro.2014-07-23.v1 21 21
Optimize the Trade-off between Risk and
Reward
Gain edge
Unlock the power
of custom
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Hedge positions and
control worst-case
loss
Reduce volatility of
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Visit the CBOE booth during the conference
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for more information
THANK YOU
CBOE Global Business Development
400 South LaSalle Street
Chicago, Illinois 60605 – 312-786-8310
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23CBOE
Disclosures
Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person
must receive a copy of Characteristics and Risks of Standardized Options. Copies are available from your
broker, by calling 1-888-OPTIONS, or from The Options Clearing Corporation at
www.theocc.com
. The
information in this presentation is provided solely for general education and information purposes. No
statement within the presentation should be construed as a recommendation to buy or sell a security or to
provide investment advice. Any strategies discussed, including examples using actual securities and price
data, are strictly for illustrative and educational purposes. In order to simplify the computations,
commissions, fees, margin interest and taxes have not been included in the examples used in this
presentation. Such costs will impact the outcome of the stock and options transactions and should be
considered. Investors should consult their tax advisor as to how taxes affect the outcome of contemplated
options transactions. Supporting documentation for any claims, statistics, or other technical data is
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